Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1. Whether an amendment to an agreement in writing, which was in existence on April 26, 1995, by the addition of a new shareholder, is significant enough to result in loss of grandfathering?
2. Whether the original shareholder agreement would satisfy the "reasonable to conclude test" in subparagraph 131(11)(b)(iii) of the grandfathering legislation?
3. Whether the grandfathering rules will continue to apply if there is a transfer of the individual's share to his holding company?
Position: 1. The amendment is significant enough to lose grandfathering under paragraph 131(11)(a) of the grandfathering legislation however, if the conditions in paragraph 131(11)(b) of the grandfathering legislation are otherwise met, the shares will continue to be grandfathered.
2. Question of fact, which needs a review of the agreement. However, if the shareholder's agreement provides that the insurance would be used to fund the acquisition of the shares upon the shareholder's death, it would be relevant information that the "reasonable to conclude" phrase is met.
3. Probably, if it is a share grandfathered under paragraph 131(11)(b) of the grandfathering legislation and a transaction to which section 51, 85, 86 or 87 would apply.
Reasons: 1. See Question #2, 1996 Ontario Tax Conference. Either paragraphs 131(11)(a) or 131(11)(b) can provide grandfathering status.
2. Question 28 of the 1998 APFF Congress, Question 8 of the CALU 1997, Technical News #12.
3. Wording of paragraph 131(12) of the grandfathering legislation.
XXXXXXXXXX 2005-014511
A. St-Amour, CA
January 18, 2006
Dear XXXXXXXXXX:
Re: Stop loss rules - grandfathering
This is in response to your letter of July 28, 2005, in which you ask several questions on the application of the grandfathering provisions to the stop-loss rules in subsection 112(3) of the Income Tax Act (the "Act").
Unless otherwise stated, all references to a statute are to the Act.
Facts
In your letter, you outlined two hypothetical situations for our consideration. Briefly, you mentioned that on April 26, 1995 two individuals each owned 50% of the shares of a corporation, the shares of which were subject to a written shareholder agreement that was in place before April 27, 1995. This agreement provides, among other things, that life insurance policies held by the corporation will be used to purchase the shares of a deceased shareholder. The life insurances policies were in place on April 26, 1995 and the death benefit of the policies has been increased from time to time to reflect the increased value of the shares. You also mentioned that the corporation has been paying the premiums on the said policies. Based on the facts that you submitted, we assume that the corporation is the beneficiary of the life insurance policies. You are of the view that the shares would be grandfathered under either paragraphs 131(11)(a) or (b) of S.C. 1998, c.19, as amended by 2001, c. 17, s. 251 (the "grandfathering legislation").
In the first scenario, you indicated that various amendments would be made to the shareholder agreement to reflect the addition of a third shareholder. You ask whether such changes would affect the grandfathered status of the shares under paragraph 131(11)(a) of the grandfathering legislation. Alternatively, you also asked whether the shares would continue to be grandfathered pursuant to paragraph 131(11)(b) of the grandfathering legislation.
In the second scenario, one of the shareholders of the corporation intends to transfer his shares to a holding company that is wholly owned by him so that he will indirectly own the shares of the corporation. You believe that the holding company's shares would be grandfathered pursuant to paragraph 131(11)(a) of the grandfathering legislation and would like our view on this.
Your request appears to relate to either a proposed transaction or a completed transaction. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments, which may be of assistance. Please note that these comments are general in nature and may not apply in a particular situation.
The stop-loss rules in subsection 112(3), which would otherwise reduce a loss realized on a disposition of shares by the amount of tax-free dividends on those shares, does not apply if the disposition of shares satisfy the requirements of subsection 131(11) of the grandfathering legislation. The grandfathering legislation to subsection 112(3) applies to a disposition of a share held as capital property, after April 26, 1995. Since 1997, the grandfathering legislation applies to dispositions of shares in the following situations:
(a) a disposition that occurs pursuant to an agreement in writing made before April 27, 1995; or
(b) a disposition of a share of the capital stock of a corporation that is made to the corporation if
(i) on April 26, 1995 the share was owned by an individual (other than a trust) or by a particular trust under which an individual (other than a trust) was a beneficiary,
(ii) on April 26, 1995 a corporation, or a partnership of which a corporation is a member, was a beneficiary of a life insurance policy that insured the life of the individual or the individual's spouse,
(iii) it was reasonable to conclude on April 26, 1995 that a main purpose of the life insurance policy was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of the share by the corporation that issued the share, and
(iv) the disposition is made by
(A) the individual or the individual's spouse or common-law partner,
(B) the estate of the individual or of the individual's spouse or common-law partner within the estate's first taxation year,
(C) the particular trust where it is a post-1971 spousal or common-law partner trust or a trust described in paragraph 104(4)(a.1), the individual's spouse or common-law partner, as the case may be, is the beneficiary referred to in subparagraph (i) and the disposition occurs before the end of the trust's third taxation year that begins after the death of the individual's spouse or common-law partner, as the case may be, or
(D) a trust described in paragraph 73(1.01)(c) created by the individual, or a trust described in paragraph 70(6)(b) created by the individual's will in respect of the individual's spouse or common-law partner, before the end of the trust's third taxation year that begins after the death of the individual or the individual's spouse or common-law partner, as the case may be;
The determination as to whether a disposition of a particular share is grandfathered from the application of the stop-loss rules in subsection 112(3) under either paragraphs 131(11)(a) or (b) of the grandfathering legislation is a question of fact that can only be determined on a case by case basis.
As stated at the 1996 Ontario Tax Conference, the addition of a new shareholder would be significant enough to result in loss of grandfathering status under paragraph 131(11)(a) of the grandfathering legislation. However, we are of the view that there may be cases where shares held on April 26, 1995 will be grandfathered under both the first and the second rules above, that is, where there were both a qualifying agreement made before April 27, 1995 and a qualifying life insurance policy on April 26, 1995. In such cases, it is possible that such shares would continue to be grandfathered pursuant to paragraph 131(11)(b) of the grandfathering legislation even if their grandfathering status was lost under paragraph 131(11)(a) of the grandfathering legislation.
Technical News No. 12 dated February 11, 1998, indicates that to qualify for the grandfathering legislation, a taxpayer must demonstrate that certain conditions related to a life insurance policy, existed on April 26, 1995. The determination of a main purpose for the acquisition of a life insurance policy can only be made based on the evaluation of the facts and circumstances of each particular case. The onus is on the taxpayer to provide evidence to support that it is reasonable to conclude that on April 26, 1995 a main purpose for the life insurance policy was to fund, directly or indirectly, in whole or in part, a redemption, acquisition or cancellation of the shares. In a situation where the shareholder's agreement provides that the life insurance policy would be used for the purchase of the shares of a deceased shareholder from his estate, it would be a relevant factor to be considered in determining a main purpose of the acquisition of a life insurance policy.
Finally, it should be noted that subsection 131(12) of the grandfathering legislation provides that if an individual acquires shares (the "new shares") in exchange for shares that were grandfathered under the rule described in paragraph 131(11)(b) of the grandfathering legislation (the "grandfathered shares") and the acquisition of the new shares arose as a result of a transaction in which section 51, 85, 86 or 87 applies, the new shares will be deemed to be the same shares as the grandfathered shares.
However, any new share received by a shareholder as consideration for a share that was grandfathered under paragraph 131(11)(a) of the grandfathering legislation would not be grandfathered under the share exchange rule in subsection 131(12) of the grandfathering legislation since this rule does not apply for the purpose of paragraph 131(11)(a) of the grandfathering legislation.
The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, the above comments do no constitute an income tax ruling and accordingly are not binding on the CRA.
Yours truly,
Section Manager
Section du secteur financier et des entités exonérées
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 2006
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 2006
Email this Content